In what is now the fourth largest bull market on record, investors — advisors included — are clamoring for alpha, or excess investment return.
But according to Francis Kinniry Jr., principal of Vanguard’s investment strategy group, most — advisors again included — are looking in the wrong place, and would do well to look in the mirror for their lack of success.
Kinniry put it much more politely than that in an interview with ThinkAdvisor at ETF.com’s annual Inside ETFs conference in Hollywood, Fla.
He used language such as “pro-cyclical behavior,” which is a polite way of saying chasing returns, but his logic is unassailable:
If numerous studies confirm that investors buy late in a bull market and sell after the crash, and if 80% of mutual fund and ETF assets are advisor-managed, that means that advisors are a big part of the problem.
But Vanguard has a solution, called Advisor’s Alpha — a term it trademarked after first publishing research in 2001 about how advisors can add value through relationship-oriented services rather than through hard-to-deliver promises about investment return.
“Advisor’s Alpha is a process or philosophy for how advisors could move the value proposition away from the traditional value proposition” of outperforming an investor’s asset allocation, Kinniry says.
“So if the average return for a 60-40 stock-bond portfolio were 8%, I would try to make 8% into 9.5%,” he continues. “That is very difficult to accomplish … We think it would be better for advisors to focus on the area where they can add real value instead of trying to outperform a passive benchmark.”
Kinniry knows whereof he speaks because he lived it as an advisor and based his early research on advisor’s alpha on that experience.
As a newly minted MBA and CFA, Kinniry joined a high-end RIA with $500 million under management catering to institutional and high-net-worth families where the minimum account size was $5 million. The firm’s largest client invested $100 million with the firm and the median account size was $12 million.
Yet most advisors, whose clients have more modest account sizes, will be interested to know that Kinniry and his colleagues — far from seeking 9.5% when the market was returning 8% — would explicitly say something like: “If the market is returning 7%, we’ll probably get you 6%.”
That calculation was based on portfolios that were 50% indexed, so with the asset manager’s low fee and the RIA’s 50 basis points (accounts were so large that they didn’t need a high fee to be profitable, Kinniry points out), a 6% return was realistic and obviated the need to take on large risks in the hopes of achieving market-beating returns.
Kinniry and his partners stressed instead the value of the estate planning, succcession planning, trust planning and the overall “deep relationships” formed with clients, helping wealthy families, for example, in advising the next generation on how to deal responsibly with money rather than coast on trust funds.
Kinniry says client retention was extremely high, and in case advisors are wondering about investors concluding they can directly invest in an index fund on their own, the Vanuard exec says there is no cause of worry.
He cites research from Greenwich, Spectrem and others saying there is very little crossover between advised investors and direct investors. “People don’t tend to switch religions too often,” he says by way of analogy.
Kinniry says the advisor’s alpha approach pays off particularly well for doctors, lawyers and other highly analytical people who are most prone to shooting themselves in the foot financially.
That is because behavioral biases mislead such investors, who are capable of studying market history but drawing the wrong conclusions. The best hip surgeons don’t vary so much year after year, but the investments are subject to cyclicality.
He cites the example of a distinguished doctor he knows who today is extremely grateful for the 1% asset management fee he pays because of his history of blowing himself up through these sort of behavioral biases.
Kinniry and his team put out steady research, since 2001, on the various ways advisors can add advisor’s alpha, with efforts to quantify each component.
For example, “the dollar weight of return of investors…who stayed with the policy portfolio — we’ve shown that value to be about 150 basis points.”
That sort of finding is especially meaningful today at a time when the market is up over 200% from its recent bottom, yet investor returns are far more modest, since scared investors remained wedded to bonds through May 2013, Kinniry says.
“Today a lot of investors are demanding to have high equity share … calling advisors every day saying 'Equities look great; bonds — what am I gonna get 0, 1, 2%?’ We’re not market forecasters but valuations look stretched,” he says, suggesting that advisors should be selling stocks and buying bonds today just as they should have done in the late ‘90s.
Regardless of investors’ asset allocation, advisors should help them stay the course.
That, Kinniry says, is really what advisors are getting paid for. Just as a nutritionist wouldn’t accept her patient’s request for Big Macs, advisors should resist irrational investment preferences.
“Disagreeing with clients who are paying you can be challenge: ‘If I don’t take money out of market, they’re going to fire me.’" he says. "But if you’re not going to act as their fiduciary and go ‘against’ them, they don’t need you.”
Check out The Financial Advice the Next Generation Needs on ThinkAdvisor.